For many product companies material costs are their largest expense.
While it seems obvious that one way to increase profitability is to minimize material costs, there are facets of the equation that warrant more exploration.
Material costs include the direct cost of materials used in the production of your products, but also include the cost of delivery and the cost of spoilage or scrap. Material levels will have a direct impact on warehouse needs, labor requirements, insurance costs, purchasing costs and other administrative costs.
Much has been written about just-in-time inventory (JIT) so I will not dwell on the benefits of receiving shipments in a fashion that is coordinated with your production schedule. However, there are some risks associated with JIT. If you have delays in receiving materials in a JIT situation, it can cause a production line to be shut down or have to be converted to making an alternative product until the goods are received. The same issues arise if the materials are not up to your quality standards. JIT implies more frequent deliveries, and while JIT reduces your warehouse requirements and other inventory carrying costs, it can increase your delivery costs. A dependence on JIT inventory means more attention has to be paid to your supply chain. A breakdown in the flow of goods deeper in the chain can also trigger outages.
Scrap and spoilage vary by industry. An intricate multi-stage manufacturing process will tend to have higher risks of scrap expense. I have seen this first hand in machine shops where parts are built in stages. A mistake in the later processes scraps not only the material cost but also the labor and burden costs from earlier steps. Materials can be damaged at any point prior to receipt by your customer. Proper protection for materials in your warehouse and on your production floor can minimize scrap expense.
Purchasing departments should make sure the company is receiving competitive pricing for their purchases. This includes having alternative suppliers and in some cases substitute materials. Make sure your suppliers can meet your shipment needs with products that stand up to your quality standards. Suppliers who have made it through the recession may find themselves lacking adequate working capital. They may struggle to finance their receivables with you and to maintain adequate inventory levels to meet your needs. It is normal to ask critical suppliers to share financial information and insurance coverages with you. Have your finance group review their information to ensure their problems don’t become your problems.
You can increase profitability by focusing on material costs but take a holistic approach that encompasses more than just the per unit cost from your supplier.
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